Here are several additional examples of common adjusting entries:
Prepaid Insurance (Deferred Expense)
Many businesses pay insurance premiums at the beginning of the insurance period, which often overlaps the company’s fiscal year. For example, if a company prepays $18,000 of general liability insurance on January 1 for coverage until December 31, they would record an asset (prepaid expense) of $18,000 on January 1.
Each month, they would make an adjusting entry to allocate a portion of the prepayment to expense. For a 12 month policy prepaid on January 1, they would debit Prepaid Insurance and credit Insurance Expense for $1,500 each month ($18,000 total prepaid / 12 months). This allocates the cost of the insurance to each month the coverage is provided.
On December 31, the remaining balance in Prepaid Insurance would be $0, since the full $18,000 has been allocated to the 12 months of expense. Any unused amount would be refundable from the insurer.
Accrued Wages (Accrued Expense)
Many companies pay employees on a semimonthly or biweekly basis, rather than for exact hours/days worked within a pay period. This results in wages being earned but unpaid as of the end of an accounting period.
For example, if a pay period ends on March 15 but employees are not paid until March 31, wages would have been earned from March 16-31 that are a liability but not yet paid out. The company would credit Wages Expense for the total earned but record an offsetting debit to Accrued Wages Payable to recognize the liability.
When the wages are ultimately paid on March 31, the payment would credit Accrued Wages Payable to reduce the liability, since the expense was already recognized via the prior period’s adjusting entry. This ensures expenses are matched to the period earned regardless of when payment occurs.
Depreciation Expense (Allocating Expense Over Life of Asset)
When long-term fixed assets such as equipment are purchased, the costs benefit multiple periods and must be allocated over their useful lives. Depreciation expense adjusting entries credit the accumulated depreciation account (a contra-asset) and debit depreciation expense each period.
For example, if equipment costing $60,000 with a 5 year useful life is acquired on January 1, year 1, annual depreciation would be $12,000 (cost / useful life in years). At year end, an adjusting entry would credit Accumulated Depreciation of $12,000 with an offsetting debit to Depreciation Expense. This process repeats each subsequent period to systematically allocate the equipment’s cost.
Accrued Interest (Accruing Interest Over Time)
For debt such as bonds payable or notes payable, interest is often paid periodically such as semi-annually rather than daily or monthly as it accumulates. Adjusting entries credit the accrued interest payable account and debit the interest expense each period to recognize expense as time passes between payments.
For a $1 million annual 8% interest note issued on January 1 that pays interest on June 30 and December 31 each year, the company would recognize 6 months of accrued interest. On June 30, the adjusting entry would credit Accrued Interest Payable $40,000 (note balance x 8% annual rate / 2 payment periods = $40,000 semi-annual accrual) and debit Interest Expense.
These are just a few common examples of adjusting entries made to recognize and accurately reflect expenses in the appropriate period as time passes, even if related cash flows occur in a later period. Adjusting entries properly match revenues and expenses and represent important accounting concepts. Please let me know if any part of these examples would benefit from further explanation or clarification.